Fixing the Eurozone

Greece: reculer pour mieux sauter

From the collection: Future of Europe


From the collection Future of Europe

As the interview with Hans Werner-Sinn illustrates, there is no monolithic “German perspective”. Of course, there are common “cultural” perspectives - the belief in fiscal probity, sound finances, and debt sustainability. Sinn is no different in this regard, but he is certainly not a simple-minded German nationalist. He believes in a “United States of Europe” with a fully functional supranational fiscal authority (along with a common army and common foreign policy, which goes beyond what many other ardent federalists are prepared to contemplate). But he very much wants a United States of Europe with a strong German accent.

What does that mean for countries like Greece? Well, Sinn is of the view that you can’t have a currency union without a common fiscal authority, and that the whole structure of the monetary union was wrongly conceived. In his words, it was like granting a dowry to the collective European Union countries without consummating a marriage. In his view, Eurozone leaders must ask themselves tough questions about the sustainability of the current system for managing debt in the EMU. They should begin by considering the two possible models for ensuring stability and debt sustainability in a monetary union: the mutualization model and the liability model.

Europe has so far stuck to the mutualisation model, in which individual states’ debts are underwritten by a common central bank or fiscal bailout system, ensuring security for investors and largely eliminating interest-rate spreads among countries, regardless of their level of indebtedness. In order to prevent the artificial reduction of interest rates from encouraging countries to borrow excessively, political debt brakes are instituted. In the Eurozone, according to Sinn, mutualisation has been realised through generous ESM bailouts and ongoing intervention by the European Central Bank . Moreover, the European Central Bank pledged to protect these countries from default free of charge through its “outright monetary transactions” (OMT) scheme – that is, by promising to purchase their sovereign debt on secondary markets – which functions roughly as Eurobonds would. The supposed hardening of the debt ceiling in 2012 adhered to this model.

Sinn advocates an alternative – the liability model – which requires that each state take responsibility for its own debts, with its creditors bearing the costs of a default. Faced with that risk, creditors demand higher interest rates from the outset or refuse to grant additional credit, thereby imposing a measure of discipline on debtors. The best example of the liability model is the United States. When US states like California, Illinois, or Minnesota get into fiscal trouble, no one expects the other states or the federal government to bail them out, let alone that the Federal Reserve will guarantee or purchase their bonds. Indeed, the Fed, unlike the ECB, does not buy any bonds from individual states; investors must bear the costs of any state insolvency. In 1975, New York City had to pledge its future tax revenues to its creditors in order to remain solvent.

And what should be done with Greece today, which appears to be on the verge of a “Grexit” from the common currency? Sinn, for one, does not think this is a disaster. He feels that Greece (and other uncompetitive Mediterranean nations) should use the opportunity afforded by an exit from the euro to restructure its economy to become more competitive before resuming membership. In effect, embrace the French notion of “reculer pour mieux sauter” (step back before leaping forward). In practice, it’s difficult to see how this can work, especially given the oft-expressed views that the euro is inviolable and eternal, but Sinn does distinguish this from the old European Exchange Rate Mechanism (ERM), by noting that there is no “snake” with a variety of national currencies linked together, but a common euro, which he feels adds more permanence to the proposal.

One can question the feasibility of Sinn’s views, but as the interview illustrates, he is thoughtful, unconventional, and challenging to those who wish to safeguard the status quo which, as events today reveal, is clearly unsustainable.

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